Under the IAS 1 of IFRS(International Financial Reporting Standard), every business entity must comply with reporting and representation of financial data. Five financial statements are the most crucial and mandatory for reporting. Balance Sheet is one of the most important financial statements among all financial statements.

The other four statements including income statement, statement of change in equity, retained earnings, cash flow, and notes to financial statements. The significant accounting policies are part of the notes to financial statements.

A balance sheet is a snapshot of a company’s financial position. It summarizes the accounting information for a specific period.

A balance sheet tells:

  • What does a company own?
  • What are the outstanding obligations of a company?
  • What is the capital structure of a company?
  • Liquidity of The company?
  • The net worth of a company

Creditors use a company’s balance sheet to analyze the company’s ability to pay back the debt. Investor assesses the profitability of a company for investment purposes. Regulators and government authorities analyze company’s statements for valuation and tax purposes.

With so many users of the balance sheet, a business owner must know how to prepare a balance sheet and understand every item on the balance sheet. In this article, we will walk through step by step process of preparing a balance sheet.

What Is Formula For Preparing Balance Sheet?

The preparation of a financial statement is based on the accounting equation.

The accounting equation suggests that a company’s assets are equal to the sum of its liabilities and shareholder’s equity. Thus, it is considered as the foundation of the double-entry accounting system.

It is one of the fundamental accounting principles. The accounting equation is constructed to justify that every business transaction affects the debit and credit sides of accounts by an equal amount. As a result, the balance of assets and liabilities is maintained.

The accounting equation is often expressed as,

Assets = Liabilities + Shareholder’s Equity

Let’s comprehend the concept with the help of an example.

Suppose company ABC has purchased new machinery on cash amounting to $50,000. What will be the impact on the accounting equation?

Assets = Liabilities + Shareholder’s Equity

+50,000(machinery asset) -50,000(cash paid) = No change in liabilities or Shareholder’s Equity

The balance sheet balance will remain the same as the amount equal to the machine’s value has been paid.

If a company ABC pays its loan of $100,000 through cash, what will be the change in the accounting equation?

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Assets = Liabilities + Shareholder’s Equity

-100,000(CASH PAID) = -100,000(liabilities written off) + No change in shareholder’s equity.

Benefits Of Preparing Balance Sheet

Why should a business prepare a balance sheet?

We have already talked about the benefits of the balance sheet for outside users. What are the benefits of the balance sheet to the company which is preparing its financial statements?

Risk Assessment

A business operating in any industry is exposed to many risks. A balance sheet represents the summary of all the financial data by classifying it under assets, liabilities, and shareholder’s equity. By looking at the company’s balance sheet, management can assess different figures and data’s long-term and short-term effects.

The current ratio of a company tells about the short-term debt-paying ability of the company. If a business organization maintains its balance sheet, management can assess the risks and mitigate them on time.

Liquidity

Again, you can assess the company’s liquidity by using the balance sheet. Ideally, a company should have positive worth, which implies more assets than liabilities. Using current ratios, acid-test ratios, and net assets ratios, a company’s ability to pay its short-term obligations and long-term loans can be assessed.

A company can assess if the debt levels are unsustainable or any other financial problem to save the business from future crises.

Efficiency

How does a balance sheet measures the efficiency of financial matters and business?

When a balance sheet is read and the income statement, it can give useful insights into how efficiently the organization is employing its current assets. The asset turnover ratio measures efficiency, and it tells how much revenue is generated by using the fixed assets and current assets.

Helpful In Financial Ratios

All the financial ratios are calculated by taking input from the balance sheet of the company. Management can calculate different helpful ratios related to financial leverage, liquidity, productivity, profitability, and solvency by using data from the balance sheet and income statement. These financial ratios enable the management to take timely action to mitigate uncertain risks a business faces every moment.

Rate Of Return

Investors, as well as the management, can find the rates of returns for future planning. The use of information is different for both users. An investor is looking for ROI to find a profitable investment. In contrast, management is looking for opportunities to invest more rigorously by leveraging the good return rate and equity.

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If a company has a good rate of return on assets, it is easy to get qualified for a bank loan. Besides, if a financial statement is updated, a company can always take timely actions to improve the rate of return.

When Is Balance Sheet Prepared?

A general misconception prevails that balance sheets are prepared at the end of a financial year. Is it true?

Yes, the balance sheet is prepared at the end of a financial year! But it doesn’t mean that a balance sheet has to be prepared only then.

The year-end balance sheet is used for a lot of external purposes. It is prepared for public disclosure, but many companies prepare quarterly financial statements too. Even monthly balance sheets are also prepared.

The frequency of preparation depends on the volume of business and financial reporting patterns of any business. However, one thing is clear that

Balance sheets are mostly prepared at the end of an accounting period. It can be a month-end, quarter-end, or year-end.

Preparing Balance Sheet Step By Step

Let’s dive into the step-by-step preparation of a company’s balance sheet!

Define The Reporting Date And Period Of Balance Sheet

The balance sheet reports the summary of the company’s financial data. It is important to define the reporting period of a balance sheet according to the financial year followed by a company. The closing of a reporting period is quoted on the balance sheet generally.

If a company reports its data annually, the balance sheet will be prepared annually, and the reporting date will be 31st December.

For quarterly reporting, the reporting dates for each quarter will be:

  • Q1: 31st March
  • Q2: 30th June
  • Q3: 30th September
  • Q4: 31st December

 For the monthly reporting, the last date of every month will be treated as the reporting date.

A header of an annual balance sheet will look like this:

Company ABC, LLC
Balance Sheet
as of 31st December, 20xx

Find Out The Assets And Add The Balances

The next step is to identify the assets of the company. Assets are the items owned by the business. Assets are classified into:

Current assets: Current assets are the short-term assets of a company that can be liquidated within 12 months. The current asset includes cash, marketable securities, term certificates, stock held for sale, account receivables, and prepaid expenses.

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Non-current assets: Non-current assets are long-term assets and categorized into fixed assets and intangible assets. Fixed assets are physical assets like building, machinery, land, equipment, property, etc. Intangible assets are non-physical assets like goodwill, patents, and copyrights.

Identify The Liabilities And Add The Balances

The next step is to approximate the liabilities. Liabilities are the obligations of a business that have to be paid. Most commonly, the following liabilities may occur in a business.

Current-liabilities

  • The current part of the long-term loan
  • Unearned revenue for services to be provided
  • Account payable due to the creditors
  • Other current liabilities
  • Outstanding wages, salaries, and expenses

Non-Current Liabilities

  • Non-current unearned revenues
  • Long-term debt
  • Deferred tax liability
  • Pension fund

Calculation Of Shareholder’s Equity

After liabilities, shareholder’s equity is calculated to compare the assets with liabilities. The shareholders’ equity generally includes issued capital, additional paid-up capital, and retained earnings.

Balancing The Totals

The final step is to balance both sides and find the total. One concern of most accountants arises that:

Why is the balance sheet balance not equal?

There might be one of the following reasons for the balance of asset and liability side not being equal.

  • There might be some misplaced or incomplete data from some accounts
  • Some transactions have been incorrectly entered
  • Currency differences also cause unbalanced totals. If a company has business in different countries or deals with different currencies, the exchange rate fluctuations lead to complications. Incorrect recording of the exchange rate by few points can create a huge difference in the balance sheet.
  • One reason can be a change in inventory because it has an impact on the cash flow. Therefore, dealing with this reduction in cash balance can be tricky and might end up as unbalanced totals in the balance sheet.

Example of A Balance Sheet

Let’s take an example of a company ABC that prepares its financial statements at the end of the year. According to the adjusted trial balance of the company, the following were the figures.

Description                                                                                                                        Debit(USD)Credit(USD)
Cash In-hand150,000 
Cash at bank175,000 
Accounts receivables15,000 
Account Payable 19,000
Shareholder’s equity 1,000,000
Land & Building400,000 
Office Equipment100,000 
Goodwill200,000 
Deferred Tax liability 3,000
Unearned Revenue 6,000
Bank Loans 300,000
Machinery & Equipment350,000 
Patents & Copyrights90,000 
Interest Payable 9,000
Outstanding Wages 8,000
Prepaid Insurance5,000 
Retained earnings 190,000
Profit Transferred from P & L Account 50,000
Marketable Securities100,000 
 1,585,0001,585,000

The balance sheet will be as follows:

Company ABC, LLC
Balance Sheet
as of 31st December, 20xx
ASSETSAmountLIABILITIES AND SHAREHOLDER’S EQUITY 
Current Assets Current liabilities 
Cash In Hand 150000Account Payable 19,000
Cash In Bank 175000Unearned Revenues   6,000
Marketable Securities 100000Outstanding Interest   9,000
Accounts receivable   15000Outstanding Expenses   8,000
Pre-paid Insurance     5000 
Total Current Assets 445000Total Current Liabilities 42,000
   
Fixed Assets Long-Term Liabilities 
Land & Building 400000Long-term loan 300,000
Office equipment100,000Deferred Tax Liability     3,000
Machinery & equipment 350000Total Long-Term Liabilities 303,000
Total Fixed Assets 850000  
  Shareholder’s Equity 
Intangible Assets Paid-up capital1,000,000
Goodwill 200000Retained Earnings                             190000 
Patents   90000+Profit From P & L                              50,000 240,000
Total Intangible Assets 290000  
    
TOTAL ASSETS 1585000TOTAL CAPITAL AND LIABILITIES 1,585,000

Final Words

We have comprehended the balance sheet topic, the benefits of the balance sheet, and how to prepare a company’s balance sheet.